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06/16/2010

Turkey Navigates the Straits of a Crisis (Part I)


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HISTORY AND COMPARATIVE CONTEXT | ECONOMIC STRUCTURE

It is almost cliché to call Turkey a bridge between worlds, but on closer inspection, the country is difficult to describe as anything else. With a foot in Europe and a foot in Asia, Turkey truly is a crossroads between the East, West, and Middle East, a role shaped by its location and cultural geography, as well as its history.

An emerging market on Europe’s doorstep, Turkey is privileged through a customs union with its largest trading partner, Europe, and ties to both the modern secular West and traditional Muslim Middle East. From 2003 to the 2008 financial crisis, the economy grew at roughly a 6% compounded average, at times achieving growth rates as high as 9%. The local stock market also prospered during this time, yielding at a 30% annualized compounded return over 2002–7, albeit with 45% volatility. At the time of writing, following a 4% GDP contraction in 2009, Turkey’s economy has resumed growth in 2010 at a rate of 4.5%, according to Economist Intelligence Unit estimates, and the local market index has approximately recovered the losses suffered from the 2008 high.

The fundamental investment case for Turkey lies primarily in its educated citizenry, relatively low-cost labor, diversified economy, and privileged access to European markets through its customs union with the EU. These advantages can be overstated because other Eastern European countries also have them, and because China’s low labor costs are difficult to beat globally, but Turkey’s relatively large population and GDP does make it a dominant competitor in the region. Economically, Turkey’s relationship to the Euro-zone is not unlike Mexico’s NAFTA-relationship to the United States.

Fundamental risks to Turkey as an emerging market come from exposure to Europe’s recession, since Europe is both a major export market and source of foreign remittances. In addition, the resistance of some European Union member countries to accept Turkey as a full EU member may ultimately turn Turkey away from the West. Turkey’s neighborhood is sometimes dangerous, and the worldwide rise in religious fundamentalism has gained ground in Turkey too. While theocratic revolution is extremely unlikely, the increased mobilization of religious movements and political parties can trigger military intervention in politics, as the armed forces step in to defend the country’s secular orientation. Finally, Turkey has chronic inflation difficulties, although these have trended downwards to more manageable levels in recent years.

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HISTORY AND COMPARATIVE CONTEXT

Turkey is the longest-running example of a secular democracy in a predominantly Muslim country, although military interventions, while brief, have occurred periodically and continue to cast a shadow over politics. Turkey’s major cities are highly cosmopolitan, with a distinguished professional class, yet parts of eastern Anatolia still resemble other developing countries in the region. The bridges between East and West, Muslim and secular, modern and developing are as striking as anywhere.

Four centuries ago, armies of the Ottoman Empire struck terror in Europe’s Christian areas, and this history, along with concern over religious differences, continues to frame some European Union member nations’ attitudes toward Turkey today when considering the full integration of Turkey into the EU. Since the end World War II, however, Turkey has pursued close ties to Europe through participation with NATO and achieving EU associate status. This growing relationship was driven in part by geopolitical needs to build alliances against the Soviet Union during the Cold War, but also by a belief that deeper engagement with the West would reinforce the country’s commitment to modernity and secularism envisioned by Turkey’s founders.

Table 1: Turkey in Comparative Perspective.
Turkey in Comparative Perspective 
Note: All data are for 2009 unless otherwise indicated. Source (accessed June 8, 2010): CIA World Fact Book, Transparency International, and the Heritage Foundation.

Table 1 puts Turkey into comparative context. With a population of 78 million, Turkey is comparable to Egypt and Germany, while its 2009 GDP, $863 billion, is roughly comparable to Australia’s and Iran’s. A per capita GDP $11,200 places it alongside Costa Rica and Romania, and its stock market capitalization of $287 billion (as of January 2008) is similar to Greece’s and Singapore’s. In terms of economic openness and freedoms, Turkey ranks near France, Poland, and Thailand, and its corruption perception index from Transparency International is comparable to Italy and Cuba.

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ECONOMIC STRUCTURE

As with many emerging markets, Turkey experimented with import substitution industrialization in the 1950s-1970s and was relatively successful with it until the oil shocks of the 1970s. In the 1980s, Turkey gradually shifted towards an export-oriented model, but has been slow to privatize state enterprises in part because the ISI model was never fully discredited. Today, the economy generates just under 2/3 of its GDP from the service sector, 1/4 from industry, and the remaining 1/10 from agriculture.

Figure 1: Evolution of Turkish Real GDP
Turkish GDP
Source: Economist Intelligence Unit (accessed June 8, 2010).

Figure 1 shows the growth and evolution of Turkey’s real GDP from 1990 to 2009. The economy has grown in fits and starts over the past two decades, but the period from 2002 to 2007 has been particularly favorable. The export sector, in particular, has grown fairly consistently, although increased imports during the boom did create a trade deficit of nearly 4.5% at the peak in 2007.

Figure 2: Interest Rates, Inflation, and Real GDP Growth
Turkish Interest Rates, Inflation, and GDP
 Source: Economist Intelligence Unit (accessed June 8, 2010).

Inflation has been a chronic concern in Turkey for decades, as shown in Figure 2, although it has not always come at the expense of real GDP growth. Economic growth has been less volatile in recent years as the introduction of inflation targeting has reduced the inflation rate to high single digits. Lower inflation has come at a cost, however: unemployment under inflation targeting has risen from 6–8% to 10–12% during “normal” years, and reached 14% during the 2008–9 financial crisis.

Turkey’s banks have weathered the recent financial crisis relatively well because they had almost no exposure to the toxic assets that brought down other banking systems. Turkey’s 2001 financial crisis hit banks harder and resulted in stricter banking regulations that protected the industry during the current crisis. Economically, the most immediate effect of the crisis has been the reduction of export earnings from Europe and the liquidation of portfolio investment funds.

Public sector finances are also in relatively good shape. Even though Turkey’s budget deficit reached 5.5% of GDP in 2009, its public debt-to-GDP ratio, at 48%, is on the low side of the global average, and well below the levels of those countries currently in crisis. Of course, Turkey’s ability to benefit from this advantage is crimped by the relatively high nominal rates paid on its public debt. Nonetheless, the fiscal discipline developed to control inflation earlier in the decade has helped contain the public sector more generally and keep Turkey from facing a Greek-like situation. Central bank control over the local currency also helps.

An advantage for Turkey is that its economy is diversified, producing a wide range of agricultural, industrial, and light-manufactured goods and services for domestic consumption and export. Key products include apricots, figs, and dates, aluminum, machinery, automobiles, textiles, and a rapidly growing tourism sector. Thus, if Turkish industry can capitalize on its proximity to Europe to differentiate itself from lower-cost producers, there are many reasons to think that—while the economy is not unaffected by the crisis—it should ultimately weather events well. A key test will be whether the high rates of unemployment will lead to increased religious radicalism or other social strains that would then precipitate military intervention. A successful coup in Turkey would not directly threaten the economy, since the military is fairly supportive of capitalism, but the uncertainty would increase political and economic uncertainty and thus reduce overall investment attractiveness.

A future installment will continue this analysis, discussing the performance and prospects of Turkish equities, debt, and currency.

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Bruce P. Chadwick, PhD, CFA, is principal at Chadwick Global Research and Consulting, an independent consulting firm specializing in macro strategy, including quantitative, emerging market, and SRI research.

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